One of the major revenue-producing items manufactured by Conch Republic is a smartphone. Conch Republic currently has one smartphone model on the market, and sales have been excellent. The smartphone is a unique item in that it comes in a variety of tropical colors and its preprogrammed to play music. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models. Conch Republic spent $750,000 to develop a prototype for a new smartphone that has all the features of the existing smartphone but adds new features such as WiFi tethering. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new smartphone.

Conch Republic can manufacture the new smartphones for $220 each in variable costs. Fixed costs for the operation are estimated to run $6.4 million per year. The estimated sales volume is 155,000, 165,000, 125,000, 95,000, and 75,000 per year for the next five years, respectively. The unit price of the new smartphone will be $535. The necessary equipment can be purchased for $43.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $6.5 million.

Net working capital for the smartphone will be 20% of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first years sales. Conch Republic has a 21% corporate tax rate and a required return of 12%.

1: Direct Cash Flow Analysis

Suppose that you are Jay McCanless and you have been asked by Shelly Counts, the president of the company, to create an Excel model with a direct cash flow forecast for the new smartphone. After you estimate the incremental cash flows from the new smartphone, calculate the NPV and IRR of the project.

2: Scenario Analysis

After you conduct the base scenario analysis in number 1, you are required to do NPV analysis for the best and worst scenarios.

• Best scenario: The unit price of the new smartphone will be $575 and the variable costs of the new smartphone will be $200 each.
• Worst scenario: The unit price of the new smartphone will be $420 and the variable costs of new smartphone will be $260 each.
• You believe that there is 50% chance to be the base scenario, 30% of chance to be the best scenario, and 20% of the chance to be the worst scenario. What is the expected NPV of the new smartphone?

3: Recommendation

Based on the analysis you conducted in 1 and 2, make a recommendation on whether or not to proceed with this new smartphone project. Outline your analysis.